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Leased plant and machinery - Changes to the taxation treatment


New tax rules have been introduced for Plant and Machinery leased by a business where the duration of the lease agreement exceeds five years. Such agreements are referred to as “long funding” leases.

To whom do the new measures apply?

The new regime will apply to both companies and unincorporated businesses entering into long funding leases for plant and machinery.

From when do the measures apply?

Generally, the new rules will only apply to leases that are entered into from 1 April 2006.

The good news is that the new regime will not generally effect existing lease arrangements. However, there are also transitional rules that can bring certain lease agreements entered into after 21 July 2005 within the new regime.

What is the effect of the new provisions?

Generally the tax treatment of a lease follows the legal form of the underlying transaction. Effectively, the lease of an asset is treated for tax purposes, as the hire of that asset. The lessor claims capital allowances on the cost and the lessee claims a trading expense for the leasing payments.

However, where a lease of over five years also meets any one of the following three tests, it is deemed to be a “long funding lease”:

1. The lease would be accounted for as a finance lease;
2. The present value of the lease at its commencement is equal to 80% or more of the asset’s value;
3. The term of the lease is for more than 65% of the asset’s remaining economic life.

Following this line of argument the new provisions state that where there is a long funding lease for plant and machinery, (the contention is that the economic reality of such a lease is that the transaction is a financing arrangement), the lease is treated as a loan to acquire the asset, rather than a hire agreement.

Accordingly with the new rules the position is:

· The lessor is taxed on the finance element of the leasing payments received and may claim no capital allowances;
· The lessee claims a deduction for the finance element and may claim capital allowances;
· The finance element is equal to the interest charged plus the profit element.

Some specific lease agreements with a term of between five to seven years are treated as outside the new regime – these will need to be reviewed.



Date: 14th April, 2007
Author: Cathy Corns


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